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We develop a continuous-time model of dynamic predatory behavior à la Milgrom and Roberts (1982). An incumbent who is privately informed about whether the demand is strong or weak faces a potential entrant who decides when, if ever, to pay an entry cost to become an incumbent’s competitor or take an outside option. The incumbent chooses its output so to affect the market price, which is a noisy signal of the market demand. We provide a characterization of Markov perfect equilibria as a solution to system of differential equations. In equilibrium, both types of the incumbent overproduce, as compared to the optimal monopoly output, and industry output is maximized just before the entry. We discuss properties of the equilibrium and its implications for consumer welfare.
